WASHINGTON (MarketWatch) — It’s been an ugly month on Wall Street. The selloff that began around Sept. 18 accelerated last week and then turned vicious on Wednesday.
The S&P 500 Index SPX, +0.19% is now down nearly 8% from its all-time high in September.
But for a majority of Americans who don’t own more than a few shares of stock, the impact of the market selloff should be limited. The meltdown on Wall Street isn’t likely to crash the economy of Main Street.
The economic recovery of the past five years hasn’t been driven by market-fueled consumption or investment. And so there’s no reason to suppose that the ups and downs of the stock market will have much bearing on what happens in the real economy.
The connections between the fortunes of Wall Street and Main Street are always tenuous, and they are particularly weak right now.
The soaring bull market of the past five years didn’t help the economy all that much. A lot of wealth was created between the bottom in 2009 and the peak earlier this year, but very little of it trickled down into the economy.
The market boomed, and profits hit record levels. But hiring and business investment improved only slowly. Businesses had plenty of money, but they didn’t want to spend their cash on hiring more workers or building new offices, stores or factories. Sales lagged behind profits.
Wall Street partied for five years, but the middle class wasn’t invited. While total wealth rose by $26 trillion, median wealth for households in the middle class actually declined. The bull market mostly benefited the richest 5% of Americans who own 82% of the stock market.
Now it seems as if the punch bowl has been taken away from Wall Street’s party, just as many have wished. Investor sentiment has turned from greed to fear. But what does that have to do with you and me?
Probably not very much. The economy is now standing on its own. It no longer needs — if it ever did — a pumped-up stock market to drive it forward. Businesses are hiring and investing at a faster pace now, not because their share price is up, but because customers are coming in the door.
By all accounts, the market had gotten ahead of itself. In the long run, the market’s value is based on the return investors will get from the underlying companies they own. Prices should have some relation to earnings.
But lately, prices had gotten too high for the underlying expected flow of earnings. The Shiller cyclically adjusted price-to-earnings ratio had risen to a seven-year high of 26.37 at the beginning of September, a level seen only three times previously and always shortly before big market collapses.
The market was getting overvalued. Investors were pricing in spectacular profit growth, but profits had already flattened out. A correction was due.
Even with this recent selloff, the Shiller CAPE is at 24.9, still in the red zone. There could well be more losses ahead before the market returns to earth.
Although the loss of wealth in the stock market might be expected to weigh on the economy, there are offsetting effects of the market decline that could boost the economy marginally. Interest rates, for instance, have come down sharply. And the dollar DXY, +0.13% has weakened over the past few weeks as the market has tumbled.
So, despite the long faces on Wall Street, financial conditions are still supportive of growth, as they have been for years. Dow 16,000 is an interesting distraction, but an unemployment rate of 5.9% and a 4.6% increase in gross domestic product are more significant numbers.
